China: NDRC Reply on RMB Fund with FIE GP

Recently, it was reported by various media sources that the
National Development Reform Commission (NDRC) had issued certain
policies requiring an RMB fund (the 'FIE GP Fund') with a
foreign invested enterprise (the 'FIE') acting as the
general partner (the 'FIE GP') and domestic investors
(exclusive of FIEs established in China) acting as limited partners
to be regarded as a foreign investor. Being defined as a foreign
investor means that the portfolio investments of such a FIE GP Fund
shall be subject to foreign investment approvals, which are read by
the public as referring to the approvals from the Ministry of
Commerce or its local counterpart (MOFCOM).

International private equity firms often structure their RMB
funds in the form of FIE GP Funds. As a result this news caused
great concern among them because their RMB funds will be defined as
offshore funds in regard to making portfolio investments and as a
result there will probably be little chance of raising new RMB
funds in the form of FIE GP Funds. After reading the related
document issued by the NDRC and based on information from various
authorities, the authors believe that there is some
misunderstanding in the market about the impact of this news.

Background

Direct investment in China by foreign investors is subject to
MOFCOM approval, and shall also be guided by the foreign investment
policies, mainly the Catalogue of Industries for Guiding Foreign
Investments (the 'Foreign Investment Catalogue'), which
categorises industries into four types: encouraged, permitted,
restricted and prohibited industries for foreign investment.
Furthermore according to the Interim Provisions for Investment in
China by Foreign Invested Enterprises, FIE's investment in
encouraged or permitted industries requires no MOFCOM approval,
while FIE's investment in restricted industries is still
subject to approval. FIEs are not allowed to invest in prohibited
industries. Current laws and regulations fail to address the
treatment of investments made by an enterprise invested in by
FIE(s), such as the FIE GP Fund, resulting in the uncertainty of
whether the FIE GP Fund's portfolio investments shall be
subject to the Foreign Investment Catalogue and MOFCOM
approval.

Before the issuance of the NDRC Reply to be discussed below, in
the authors' view, the treatment of FIE GP Funds shall be no
less favorable than that to FIEs, which means, (i) the FIE GP
Fund's investments in encouraged or permitted industries shall
not be subject to MOFCOM approval; (ii) due to the lack of
regulation regarding the approval requirement and process, the FIE
GP Fund's investments in restricted industries shall not be
subject to MOFCOM approval; and (iii) FIE GP Fund's investments
in prohibited industries is likely to be prohibited. Having said
that, there exists uncertainties and local authorities in different
areas may have different views and practices.

Breakthrough by local rules

The Shanghai Government made a breakthrough on this issue by
promulgating the Implementation Measures on Foreign-invested Equity
Investment Pilot Scheme in Shanghai (the 'Shanghai Pilot
Measures') on December 24 2010 and is widely recognised for its
introduction of the concept of QFLP (Qualified Foreign Limited
Partner). The Shanghai Pilot Measures also bring a favourable
treatment (the 'QFGP Treatment') to the FIE GP Fund that,
if the FIE GP is qualified and approved to participate in
Shanghai's pilot scheme, it may make up to 5% capital
contribution to the FIE GP Fund and such capital contribution shall
not affect the original nature of the FIE GP Fund, which means the
FIE GP Fund will be treated as a domestic fund without foreign
investment, regardless of the fact that its FIE GP's capital
contribution. Before the NDRC Reply, it was unclear whether that
could be further aggressively interpreted as that the FIE GP
Fund's portfolio investments shall not be subject to foreign
investment policies. Also, whether the QFGP Treatment pursuant to
the Shanghai Pilot Measures, a local policy, may be recognised in
other areas outside Shanghai is still unclear.

The NDRC Reply

The authors understand that the said news came from the Reply on
Relevant Issues Relating to Foreign-Invested Equity Investment
Enterprises issued by the central level NDRC (the 'NDRC
Reply') in response to the Shanghai NDRC's request to
clarify the applicability of the Foreign Investment Catalogue to
the Blackstone RMB fund.

We believe the Blackstone RMB Fund is in the form of FIE GP Fund
receiving the QFGP Treatment according to the Shanghai Pilot
Measures. The NDRC Reply clarifies that, the Blackstone RMB fund
and other RMB funds in the similar structure (i.e., the FIE GP
Funds) shall be administrated by foreign investment rules and
policies and the Foreign Investment Catalogue is applicable to the
portfolio investments of such funds.

However, the NDRC Reply doesn't require the FIE GP Funds to
follow the MOFCOM approval processes for portfolio investments as
if they are foreign investors, which is beyond the authority of the
NDRC.

After the issuance of the NDRC Reply, relevant NDRC officials
further explained at a non-public occasion that (i) the NDRC Reply
was a reply to Shanghai NDRC's request on specific issues, but
not a new policy or regulation; (ii) when making portfolio
investments, such FIE GP Fund shall go through the foreign
investment project approval process with NDRC or its local
counterpart. We understand even for foreign investors, such NDRC
approval is often unnecessary in general M&A deals if no new
construction project is involved. Given that "the NDRC Reply
is not a new policy or regulation", the authors tend to
believe the same treatment regarding NDRC approval shall apply for
the FIE GP Fund, and therefore, the impact on FIE GP Funds in
respect of NDRC approval process may not be substantial.

Based on certain information from MOFCOM, we understand
MOFCOM's position is consistent with the NDRC Reply. MOFCOM
also indicated that the FIE GP Funds shall follow the foreign
investment policies, mainly the Foreign Investment Catalogue. No
investment is allowed in the prohibited industries, but the
investments in encouraged, permitted and restricted industries are
generally allowed, provided that restrictions in restricted
industries shall be followed (this appears not to be a big issue
given that the restrictions are often the upper limit of foreign
investment such as 50% etc., and the indirect foreign investment
percentage in the FIE GP Funds is much less than that). In respect
of the approval process, as indicated by MOFCOM, the FIE GP
Fund's portfolio investments are not subject to MOFCOM
approvals, but prior oral consultation with MOFCOM before making
investments is suggested, especially for investments in restricted
industries.

Conclusion

Based on the above, we believe the impact of the NDRC Reply is
not as serious as indicated in the news. For the portfolio
investments of FIE GP Funds, foreign investment policies, mainly
the Foreign Investment Catalogue, shall be followed. However, in
respect of the approval process, MOFCOM approval is generally
unnecessary, and NDRC approval is required presumably for
investments involving new construction projects, which is often not
the majority of the portfolio investments of an FIE GP Fund.

The NDRC Reply is not good news for the FIE GP Funds, but on the
other hand, it brings about some certainty regarding the treatment
to their portfolio investments. For the FIE GP Funds with no focus
on the prohibited industries, the impact of the NDRC Reply may not
be substantial.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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